New York Markets After Hours

Spotlight on Goldman as commodities hearings begin

Firm, first to benefit from exemptions 18 years ago, must now fight to keep them

By

MomingZhou

NEW YORK (MarketWatch) -- Goldman Sachs Group, already under fire for reaping record trading profits in the aftermath of the financial crisis, is now fighting to defend one of its biggest sources of revenue -- commodities trading -- with regulators considering setting limits on Wall Street speculators.

Representatives of the firm, along with those of other big investment banks, are scheduled to appear at a series of hearings held by the Commodity Futures Trading Commission starting Tuesday -- part of the Obama administration's biggest move yet to clamp down on commodities speculation, which has roiled the prices of everything from oil to corn and wheat in recent years.

At issue for Goldman Sachs
GS, -1.60%
is a major exemption it enjoys from limits on trading in certain types of agricultural commodities. Such an exemption is usually reserved for traders classified as "hedgers," such as farmers or food producers who depend on stable prices for their businesses.

Goldman opened the door for investment banks to apply for a similar status when it won the first exemption 18 years ago to help its big institutional clients in commodity-index trading, or investment in a range of commodities by tracking a major index.

The result, according to some members of Congress, has been a surge in all commodity speculation in the past few years, pushing oil prices near $150 a barrel and gold prices above $1,000 an ounce.

Speculators' index trading is "creating price disruptions for producers and consumers," said Sen. Carl Levin, D-Mich., late last month after the release of a 247-page report documenting how index traders have made large purchases on the wheat-futures market in Chicago and pushed up futures prices over the past few years.

It's time for regulators to "change course, rein in commodity index traders and clamp down on excessive speculation that is disrupting commodity prices," he added.

Besides considering removal of the special exemption, the CFTC, the U.S. futures market regulator, is also thinking of adopting position limits on all commodities, not just in agriculture. The move could curb the growth of some major commodity exchange-traded funds.

The CFTC "must seriously consider setting strict position limits in the energy market," said CFTC Chairman Gary Gensler, who worked for Goldman for nearly 20 years before being confirmed in May as the new head of the CFTC. He added that he has called his staff to research and outline "every authority available to the agency" to protect the markets and the public." See related story.

The commission has planned to hold three hearings, including the one Tuesday. Representatives from Goldman and J.P Morgan Chase & Co.
JPM, -0.62%
the two biggest holders of derivative assets, are scheduled to attend the second hearing on Wednesday.

Goldman opened the door for investment banks when it won the first exemption 18 years ago to help its institutional clients in commodity-index trading.

'Unintended' consequences

Goldman argues that any new limits will severely impact liquidity in commodities markets, hurting both large and small investors by reducing their access to these markets. The bank derives almost half of its revenue from trading commodities, currencies and bonds. (It doesn't break out commodities by themselves.)

"Attempts to regulate volatility have rarely -- if ever -- succeeded," said Steven Strongin, a Goldman managing director, in testimony delivered last week to a Senate committee regarding Levin's wheat report. "Yet they often have unintended and significant consequences."

Brad Hintz, analyst at Sanford C. Bernstein & Co., estimated that commodities trading accounts for about 8% to 9% of Goldman's revenue. While the percentage is not as big as fixed-income trading, it's an important sector for Goldman because "there are only a handful of major players."

"It's a powerful, powerful piece of the firm," said Hintz.

The CFTC's rule-making process is still in its early stages, and it's not clear whether the hearings will ultimately lead to the adoption of new rules. Michael Duvally, a spokesman for Goldman Sachs, declined to comment.

At the crux of the debate are the so-called commodity index investments, the total value of which has been estimated by MarketWatch at about $150 billion. See earlier story on the analysis.

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